Jean Marie Part 1

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What the Eagle is eyeing 38 Outlook Profit 19 September 2008

Jean-Marie Eveillard of First Eagle Funds is a legendary value investor who oversees $36 billion across six funds. The 68-year-old Frenchman has a stunning track record: During his 30-year stint, the First Eagle Global Fund handed in 15.5 per cent average annual returns to investors compared with 11.1 per cent for the MSCI World Index. Although he regrets having missed the bus to India – he has been a marginal investor in the country – the fund is now eagerly scouting for opportunities. Read on to get an insight into the investment style that went on to make Eveillard a legend, his views on world equity markets and why he thinks India is an exciting story. First up, his take on the world of investing today. Mohammed Ekramul Haque

H

bloomberg

e didn’t start out as a value investor, but today global investment manager Jean-Marie Eveillard has become one of the world’s leading names in value investing. It may have been quite a surprise to the 68-year-old Frenchman himself, who says that no one in his family ever had the slightest inclination towards investing “My father, my grandfathers, my great-uncle, and beyond all worked for the French railroad begin-

ning in the mid 19th century,” he says. Eveillard then tried to convince his “My father was an engineer, I had four bosses in France to let him try his hand brothers and nobody was interested in at value investing. But they wouldn’t investing.” give in and it took 10 years before he Yet, for someone coming from a famwas finally allocated a $15 million fund ily that had worked in the railroads in 1978 called the Socgen Internationfor generations, that did not prove to al Fund (it would later be known as the be handicap as Eveillard went on to First Eagle Global Fund). Eveillard rebecome one of the greatest investing tired from managing the well-known minds of our times. fund in 2004 but came back in March Eveillard’s first brush with investing 2007 after the sudden exit of his succame when he joined a French busicessor. ness magazine as an intern. Quick  ly thereafter, he acquired his degree The story in Asia from a business school, and started his Incidentally, the short period during long innings with Société Générale, a which Eveillard retired – 2004 to 2007 French bank, as a security analyst. His – also happened to be one of the best job consisted of analysing stocks and times for Indian equities. But First Eain 1968, his company sent him to New gle stayed steadfastly away from IndiYork to cover the big stocks there. an stocks. Eveillard admits that was a It was here that Eveilmistake: his skepticism lard turned into a followin a rising market kept er of value investing. him away (wrongly) from The world has It was accidental: one “changed” now and Indian stocks. In 2003, day, as Eveillard was cyFirst Eagle did make cling with friends from there are countries some nibbling attempts the Columbia Business such as China and at investing here, but as School through Central India which are markets continued to Park, one of New York’s becoming more soar, the fund refrained most famous landmarks, from making fresh purimportant globally they got to discussing chases. “I stopped buyBenjamin Graham (the ing when I shouldn’t pioneer of value investhave,” says Eveillard. ing). Intrigued by the conversation, (Two stocks his fund still owns from Eveillard immediately went to a bookits 2003 purchase are Tata Motors and store and bought Graham’s books Nestle India.) (The Intelligent Investor and SecuriHistorically, Eveillard says, he has ties Analysis). They were a revelation rarely been inclined to invest in emergto Eveillard. “That was when I saw the ing markets. But he says the world has light,” he would jokingly remark later. “changed” now and “there are coun19 September 2008 Outlook Profit

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tries such as China and India which clear attack by North Korea but more economic problems that will emerge are becoming more important globfrom the prospect of unification of the as banks get rid of their excessively ally from an economic standpoint”. two Koreas. Eveillard says the unificaleveraged positions. It will take a long And with stock markets having surtion of West and East Germany nearly time, he says, before the system starts rendered much of their astronomical two decades ago was an unfavourable to operate smoothly again. gains in the recent past, the time may move from an investing viewpoint. Not surprisingly, he doesn’t have now have come to look at stock invest“The same story has the risk of playa very high opinion of banks today, ing once again. ing out in Korea,” he adds. which he says are like black boxes and Indeed, that may be one reason why   disguised hedge funds. last month, Eveillard deputed research The American pie While some of them may seem like analyst Vinodh Nalluri to ‘reconnoiter’ On the sub-prime crisis, Eveillard begood value plays and even boast relathe Indian equity scene (See interview lieves that the troubles are not concentively strong balance sheets, Eveillard on Page 43). trated only in the US, as its ripples are is reluctant to place his trust in them Surprisingly, China’s now being seen around given the lack of transparency in their scorching growth rates the world. It comes after more complex dealings such as derivadon’t impress Eveillard The old-fashioned a 25-year credit boom, tive contracts. much either as he re- investor also turns interrupted only briefBanks, he proclaims, are no longer in mains extremely suspi- up his nose at ly in 1990. Like several the simple business of lending money cious of the country’s gloomy prophets, Eveilto customers; instead, they make their accounting standards. In- hedge funds and lard says this may be the money today by trading in speculative stead, he believes that if private equity as worst credit crisis the derivative contracts. And despite the you want to play the Chi- he thinks they world has ever seen since big writedowns by some of banking’s na market, you should in- are no more than the Great Depression of biggest names, he says it’s still hard to vest in Singapore, Japan the 1930s. And the worst figure out how much bad debt is still day traders who and South Korea. may only just be coming. there in the system. All said and done, he ac- simply use a lot of Eveillard is also worried An exception to Eveillard’s dislike for knowledges that Asia is leverage about the long-term conbanks is American Express. Though where the action will take sequences of the unusuthe stock has tumbled over worries place in future. Eveillard al steps taken by the US about credit card defaults, Eveillard now believes that emerging markets Federal Reserve to prevent the crisis likes the business model. Express decould offer some good growth opporfrom spiralling out of control. Among rives its revenues primarily from fees tunities, having come off their unsusthe possible consequences are a fall in charged to merchants and not from tainable highs. the status of the dollar as the world’s extending revolving credit facilities to Besides, he remains optimistic about reserve currency and the possibility of card-holders. That makes the compainvesting in Japan, a nation that has accelerated inflation in the US. ny well placed, according to the French only recently emerged from the grip Eveillard also believes that the Fed investor, to continue benefiting from of a 13-year bear market. Every sort of needs to take some blame for the curthe increasing use of plastic across the stock, at the moment, he points out, is rent crisis since it was the Fed’s poliglobe. going very cheap. Several stocks are cies of easy money that led to the The old-fashioned investor also turns now trading at or below net cash level, excesses of the recent past. He says up his nose at hedge funds and private meaning the value of cash and marketcurrent chairman Ben Bernanke can equity - two of the hottest buzzwords in able securities minus all financial debt do little than postpone the inevitable investing today – as he thinks they are is greater than the current market capBEATING THE ODDS italisation of a stock. Such stocks have Since inception, First Eagle Global Fund has outperformed the MSCI World Index practically vanished from the US and European markets, says Eveillard. First Eagle Global Fund - Class A (without load) MSCI World Index average annual returns# (in %) As a country, Japan now accounts for 21.15 per cent of the First Eagle Global 15.12 Inception (Since Jan 1979) 10.69 Fund. Incidentally, in the summer of 1988, 12.59 15-yr 7.55 Eveillard sold his last Japanese stock even as the Japanese stock market 13.57 10-yr 3.96 rose to become the second biggest equity market in the world. Avoiding 15.10 5-yr 10.99 the crash, thereafter, proved the point. Though he missed out the last leg of 10.56 3-yr the rally, he avoided the big crash. For 6.76 several years the fund owned nothing -2.23 12-mth in Japan which was by 1989 the second -10.88 biggest equity market in the world by -7.03 3-mth market cap. “We owned nothing be-8.86 cause the whole market had moved up. -2.67 1-mth We can disappear from a large equity -2.44 market or we can have a large stake in -5.79 a small market like Switzerland, de2008 (Till July 31, 2008) -12.75 pending on the situation.” -15 15 20 -10 -5 0 5 10 As for the rest of Asia, Eveillard picks # The average annual returns shown above are historical and reflect changes in share price, reinvested dividends and are net of expenses out South Korea as a risky bet, not so Source: First Eagle Funds - July 2008 report much because of the threat of a nuOutlook Profit 19 September 2008

no more than day traders who simply use a lot of leverage to produce good results. It’s a strategy Eveillard eschews because leverage can take away your staying power, something that every value investor aspires to have.  

Covering up

From a long-term perspective, Eveillard says he sees value in all global markets although it does seem more challenging to find it in developed countries such as the US and Europe. Stocks in developed markets are down by 20 per cent from the highs of October 2007 following a five-year bull run. But that’s not much. “It makes it difficult to come up with attractive securities in businesses which we think we understand, we like and we don’t overpay for the security,” he says. “Since the beginning of the year it has been less difficult for us to find such securities in Japan than in the US or Europe,” he adds.  So far, investing in foreign stocks has been pretty much like holding cash -“it’s residual,” he says. But the strategy can vary. “If we find many attractive stocks, we will own many.” His positions in gold are more as a hedge against what economic historian Peter Bernstein calls ‘extreme economic difficulties’, when the market falls for a protracted period of time. The Global Fund has about 5.09 per cent of its money invested in bullion and 3.69 per cent in gold mining securities, but Eveillard is open to a rethink on gold if its value rises further. Even as many analysts remain bullish on the precious metal, Eveillar says he is clear about his goal of investing in gold: I am not looking at absolute returns but more at reducing the damage. It’s insurance, but the premium on gold is now much more expensive at $800 than at $250 and I may decide at some point that there is no risk of something cataclysmic happening, which means that I don’t need insurance.”  As for currencies, he hedges 50 per cent of his exposure in the euro, but remains completely unhedged against the yen because he considers it undervalued against the US dollar. He also expects China to allow its currency to rise following a rise in inflation there.  

Becoming quality conscious

Eveillard started off with the Graham approach to investing that placed prime importance on stocks quoting below their intrinsic value purely based on their financials. Later, he switched to the Warren Buffett approach which studied competitive advantage and sought companies that were likely to

CLOSE CALL: Eveillard with Bruce Greenwald, director-research, First Eagle Global Fund

well-spread

First Eagle Global Fund seeks long-term growth of capital by investing in a wide range of asset classes Foreign currency bonds and note 2.86

US dollar bonds and note 2.52

Gold bullion 4.46

US dollar cash and equivalents 18.21

US stocks 25.88

Foreign stocks 46.07 in % Total assets: $22 billion as on October 2007 Country composition of portfolio in % United States 32.77 United Kingdom 0.67 Japan 15.24 Thailand 0.48 France 10.6 Brazil 0.46 Switzerland 5.36 India 0.38 South Korea 5.27 Malaysia 0.28 Italy 1.54 Spain 0.25 Netherlands 1.51 Belgium 0.21 Germany 1.34 Taiwan 0.21 South Africa 1.19 Canada 0.19 Mexico 1.14 Sweden 0.11 Hong Kong 1.11 Other 0.42 Singapore 1.06 Source: Annual report, 2007

do well even 10 years later. Both styles, however, try to find stocks below their intrinsic values. It’s impossible not to notice the reverence in Eveillard’s voice when he talks about the Oracle of Omaha (Buffett). So it’s not surprising to note that Berkshire Hathaway, Buffett’s holding company, accounts for the Global

Fund’s single-biggest holding after gold at 2.2 per cent. Eveillard has an interesting take on his Berkshire holdings. Berkshire, according to him, provides a safe vehicle in a bear market with a high quality management and $40 billion in cash to buy companies as their prices tank. He likes the company’s defensive strategies in the short term and offensive moves for the long term. He considers his purchase of Berkshire stock at a discount to its net asset value as a case of buying Buffett’s talents and skills and not paying for it! A company, Eveillard thinks, is comparable to Berkshire is Swiss foods giant Nestlé. The value investor has been quite upbeat on Nestlé for a while. Factors swinging in favour of the company are its huge cash flows and smart acquisitions such as Jenny Craig and Gerber baby foods. He continues to hold some shares of Nestlé’s Indian subsidiary. Another European firm he likes is French pharma company Sanofi-Aventis. The stock has been battered in recent times over fears that it could lose some patents on its existing drugs, especially after the US regulatory authorities rejected its anti obesity drug, Acomplia (it has already been approved in Europe). Eveillard, however, thinks the company has one of the best pipelines of new products compared with other companies. The seasoned investor openly admits to being more of a Buffett follower than a Graham one today. That’s because Graham’s approach requires picking stocks that were trading at a discount to the actual value and booking profits when the discount was recognised and eliminated by the market. Eveillard doesn’t believe this approach could hand in spectacular results in today’s 19 September 2008 Outlook Profit

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Source: Eveillard’s letter to shareholders in 2007 (Annual report)

times. “We don’t find any Graham-type stocks today. At least, no large-cap stocks are available in the US or in Europe, except in Japan.” Which is why he roots for the Buffett style. According to Eveillard, all potential investments can be condensed into three-four major business characteristics, which highlight the main facets about the business. Take, for example, the newspaper industry. While it can be argued that the industry has an unclear long-term business outlook, the fact remains that newspapers still rule as the top advertising space for local businesses. Even though you have television, radio and the internet as mediums of advertising, they have not been able to replace the newspapers as the media of choice for advertisers. Want proof? Take a look at any local newspaper at any day of the week. The chances are high that you are going to find as much space devoted to local ads as they are to actual news content. This advertising is what drives revenues for newspapers and there remains no significant alternative that provides a comparable size and reach to the target local population. Even the internet doesn’t come close.  

The avoidables 42

Are there any businesses Eveillar says no to? Most value investors dabble very little in the technology sector, Outlook Profit 19 September 2008

which by definition is a rapidly-changwhat different look at a business/stock ing field with typically high valuations. sometimes. A typical trend seen with Eveillard belongs to the ‘unadultervalue investing is that there are periated’ class of value of inods, especially in bull ralvestors. Currently, he We don’t like lies, when such investors refuses to look at stocks the idea of tend to underperform the of banks and brokerage broader markets. buying blind and firms (primarily in develIt was a similar case with oped markets) because of if we don’t have Eveillard. In the bull runs uncertainty in their earn- confidence in the of the early 1990s and esings and their book val- numbers as they pecially in the technolues. “We don’t like the ogy-driven frenzy of the idea of buying blind and if are recorded then late 1990s, Eveillard dewe don’t have confidence we will give cided against investing in the numbers as they it a pass in technology, media and are recorded then we will telecom stocks. It resultgive it a pass,” he says. ed in the Global Fund underperformValue investors are known to pick ing the rising markets. up stocks that quote below their asset Though the Fund did give absolute values. One such pick of Eveillard’s returns, a lot of investors cashed out to was Gaumont – a film production invest in the hot favourites of the time. company, but Eveillard did not buy it In fact, so promising and enticing just because it was trading cheap. He were these ‘hot’ stocks, that the Global snapped it up because he realised that Fund lost 7 out of every 10 of its share“the real assets of the movie studio was holders in 1997-2000. But rather than its movie library, the movies that they follow the crowd and flavour of the seaproduce every year. So you have to son, Eveillard remained true to his inanalyse the value of the movie library. vesting beliefs. After the bubble burst, They also happen to own real estate the returns came back—and so did the because they have movie theaters in shareholders. every medium–sized town in France. The seesawing fortune of the fund They are usually right in the middle of during those exuberant times is evithe city and every now and then, they dent from the numbers. In early 1997, forget about the movie theatre and reEveillard oversaw $6 billion; by 2000, develop the real estate. It illustrates it was down to $2.5 billion. Today, he how investors need to have a somemanages close to $36 billion. p